Project Financiers' and Insurers' Roles in Promoting Social Responsibility
in the Developing World1
January 2004
While project financing is important, projects
undertaken in the developing world that are managed by socially responsible
sponsors, financiers, and insurers prove to be the most profitable.
by Daniel
Wagner2
Asian Development Bank
The importance of project finance in promoting infrastructure development
in the developing world is well-known. Without the billions of dollars of support
generated for infrastructure projects through the use of project finance, hundreds
of millions of poor people in the developing world would not have access to
basic needs such as electricity, clean water, and sewage treatment.
Typical project financing involves the issuance of a non-recourse loan, wherein
the sponsor has no obligation to make payments on the project loan if revenues
generated by the project are insufficient to cover the principal and interest
payments. Lenders seek to minimize the risks associated with making non-recourse
loans by requiring indirect credit supports in the form of guarantees, warranties,
and other covenants from the sponsor, its affiliates, or other third parties
involved with the project.
Political risk insurance (PRI), which protects a sponsor or lender against
noncommercial risks (such as expropriation, currency inconvertibility/nontransfer,
political violence, or breach of contract) is often utilized to remove country
risk from the equation. Project sponsors and lenders thereby assume the commercial
risks associated with a given project.
The Project Finance Challenge
Project financiers have had to balance their desire to participate in sound,
profitable business ventures with the needs and capabilities of the people and
governments of developing countries, as well as the interests of non-governmental
organizations (NGOs). This has been a slippery slope for many in the project
finance business. Project sponsors, financiers, and insurers alike have had
to find balance between the many competing forces that impact the construction
and operation of infrastructure projects in the developing world. Their need
and desire to adhere to strict credit, accounting, design, construction, and
operational standards has often conflicted with equally important objectives
such as strict environmental compliance, greater socioeconomic benefits for
workers, and the rights of indigenous peoples.
Until approximately 10 years ago, project sponsors, lenders, and insurers
did not pay sufficient attention to the latter issues. Since non-recourse project
finance is a relatively new phenomenon—having come about in the early 1990s—the
emphasis tended to be on how to get an important project in a difficult country
funded, rather than how to do so in a manner consistent with the objectives
of all parties involved. What project financiers often did not appreciate was
that it was in their interest to create a win/win environment with the governments
and people of the developing world.
Now that project finance has become a standardized means of promoting infrastructure
development, the project finance industry as a whole (which includes the sponsors
and PRI providers) has come to realize that it is very much in its interest
that:
- The people who work at each project, as well as local inhabitants, have
a sense of participation in and belonging to each project.
- The long-term interests of projects are served by meeting the long-term
interests of the governments and people of the countries where these projects
are located.
- A fair and competitive long-term price should be charged for services
provided.
- A uniform, conservative environmental standard should be used (World
Bank standards are now commonly used).
- It contributes to the long-term peace and stability of the country and
region where a project is located.
Businesses are increasingly recognizing that only in stable operating environments
are projects most likely to earn an acceptable rate of return. What is perhaps
most important is that a project not contribute to or accentuate perceived imbalances
between ethnic groups, social classes, or geographical subregions. Particularly
in areas where conflict exists, extra attention needs to be paid to ensuring
transparency in all aspects of project implementation.
The Importance of Corporate Social Responsibility
“Social responsibility” has become an integral part of the planning and implementation
of infrastructure projects since the 1980s. Project sponsors, financiers, and
insurers have learned some tough lessons about the dangers of not paying sufficient
attention to these issues.
A good example of the possible consequences of not paying enough attention
to the social and environmental issues associated with owning and operating
a mine is Bougainville in Papua New Guinea (PNG). In 1988 a small group of villagers
blew up some of the mine's installations, coming in the wake of demands for
compensation for loss of land and resources to the project, and alleged pollution
of the local river system. Refusal by the mine owner and the PNG government
to address the demands prompted escalating guerilla action against the mine
and its employees. The company closed the mine down the following year, and
it has remained closed. Thousands of people died in an ensuing civil war, and
litigation against the mine and its owners continues to this day.
NGOs have also learned some lessons. One of the best examples is the Freeport
mine in West Papua (formerly, Irian Jaya), Indonesia. An NGO sought to have
Freeport’s PRI canceled for alleged violations of the environmental conditions
set out in the insurance provided by the Overseas Private Investment Corporation
(OPIC, a U.S. Government agency) and the Multilateral Investment Guarantee Agency
(MIGA, a member of the World Bank Group). Because covenants of the insurance
appeared to have been breached by the company, OPIC canceled the coverage.
Freeport took OPIC to court, had the insurance reinstated, and then itself
canceled OPIC’s and MIGA’s insurance. The NGO’s objective of stricter environmental
compliance backfired. When the insurance was canceled, Freeport was no longer
obligated to adhere to strict, internationally accepted environmental regulations.
Many mining companies have subsequently made great strides in taking the
initiative to avoid conflict with NGOs and indigenous peoples by ensuring that
they are inclusive in the planning, construction, and operation of mines. Before
RTZ built the Lihir gold mine in PNG, it spent a great deal of time establishing
strong relationships with tribal leaders, understanding the concerns of local
inhabitants, and negotiating a sensible agreement with the government. They
went so far as to remunerate islanders for every coconut tree that was cut down,
and they studied 100 years of islander family histories to establish property
rights based on written history. The banks that financed the mine, and the PRI
providers who insured it, recognized the benefits of a carefully thought out
approach to making an investment in a country as culturally complex as PNG.
These examples demonstrate that it is in all parties’ interest to collaborate
in achieving mutually satisfactory guidelines for the construction and operation
of infrastructure projects in the developing world. It is only through cooperation
and collaboration that the objectives of all parties can be reached.
Public/Private Sector Collaboration
Multilateral Development Banks (MDBs), such as the Asian Development Bank
and the World Bank, have a unique role to play in this regard. Since their work
is by nature oriented toward promotion of development and the alleviation of
poverty, the concept of social responsibility strikes a familiar chord. MDBs
have strict covenants governing all aspects of their participation in project
finance. From a “no child labor” policy to a requirement for total transparency
to no tolerance for bribery and corruption, MDBs have played a pivotal role
in ensuring that social responsibility is a common theme in the projects they
become engaged in.
Many private sector banks and insurers have attained a surprising degree
of convergence with the MDBs in the general area of social responsibility. In
addition to the commonality that has been achieved in applying World Bank environmental
standards to projects that are financed and insured in the private sector, the
type of due diligence that is now applied by most private sector institutions
has achieved a remarkable degree of similarity with those of the MDBs. While
public sector insurers have, for example, addressed a host of developmental
and social responsibility issues in the natural course of conducting their project
risk analyses, many private banks and insurance companies now routinely address
the same issues during their due diligence process. In determining whether a
project is worth supporting, for example, it is now common to assess the degree
to which substantial tax revenues are generated, local workers are hired, and
technology transfer is present.
Banks and insurance companies face a host of performance, reputation, and
ethics issues when engaging in project finance, particularly now that there
is such emphasis on the whole concept of “corporate governance.” PRI providers,
in particular, have moved from making “traditional” assessments of country risk
based largely on the social context in which a project operates to better understand
the degree to which infrastructure projects impact the wider geographical area
and contribute to indigenous and cross-border conflict. This is particularly
important because so much foreign direct investment in the developing world
exists in areas that are inherently politically unstable. Promoting corporate
social responsibility is therefore an underlying, albeit indirect, objective
of PRI providers.
Information Sharing
Despite the great progress made in the convergence of public and private
PRI providers’ interests, there remains a need for even greater collaboration
with respect to information gathering and sharing. MDBs and export credit agencies
(ECAs) have a distinct advantage in collecting project-related information because
they have access to sources private sector entities do not have.
For example, MIGA has access to IMF and World Bank Group data, and OPIC can
access any number of information sources from within the U.S. Government. Similarly,
information gathered from local sources by private sector institutions could
prove to be extremely valuable to MDBs. All such institutions could benefit
from greater adherence to widely acknowledged guiding principles, such as the
OECD’s Guidelines for Multinational Enterprises, or those of the United Nation’s
Global Compact Conflict Dialogue. Enhanced information sharing, and the establishment
of greater commonalities in project assessment and operational safeguards, will
contribute to a higher degree of conflict avoidance in the project finance process.
The Path Forward
Private sector sponsors, financiers, and insurers of project finance-related
infrastructure projects should be given credit for having moved solidly in the
direction of corporate social responsibility. It is clearly in the interests
of all parties involved in the development process that the maximum amount of
attention be paid to promoting social responsibility, and to minimizing the
potential for conflict. Much remains to be done.
Greater information sharing is one important aspect to enhancing the risk
assessment, which is key to being able to better predict where problems are
likely to arise. Generating accurate risk assessments is critical to increasing
the flow of foreign direct investment to the most difficult conflict ridden
areas of the globe. The problem is that as the realities of the post-September
11 world become clearer, the utter unpredictability of political events makes
the creation of more accurate risk analyses even more difficult to produce.
Where and when will the next terrorist attack occur? What will its impact
be on the foreign investment climate? Will a host government’s response to terrorist
attacks create an investment climate that is less conducive to attracting foreign
investment? These are the types of questions political risk analysts now face.
MDBs can play a better, more effective role in supporting access to project
finance during periods of crisis by improving the finance methodologies they
use so that they can be quickly and economically introduced into new markets,
even before a crisis starts. They can focus on filling market gaps that might
appear, so that capital flows from private banks may remain open longer.
MDBs can also consider using the least amount of intervention possible in
times of crisis, giving priority to financing tools that help private-to-private
flows first, leaving the public-to-public foreign exchange loans as a last resort.
MDB intervention can and should occur in times of crisis, but only when the
ordinary functioning of capital markets fails, so as to avoid creating a future
financial burden in crisis-ridden countries. The loans provided by MDBs must
eventually be repaid.
Finally, increased adherence to principles of corporate social responsibility
among all stakeholders in the project finance business will certainly minimize
the extent to which such business aggravates conflict-prone locations. Increasingly,
project financiers are insisting that adherence to such guidelines be a condition
precedent to issuing loans to projects. As the example of RTZ in PNG above illustrates,
future conflict between project and local stakeholders can be anticipated and
even neutralized by thoughtful planning. In the future, the hope is that projects
that are managed by socially responsible sponsors, financiers, and insurers
will prove to be the most profitable. Yes, it can be done.
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